Blockchain is transforming everything from payments transactions to how money is raised in the private market. Will traditional banking embrace this tech or be replaced by it?
Blockchain technology provides a way for untrusted parties to come to agreement on the state of a database, without using a middleman. By providing a ledger that nobody administers, a blockchain could provide specific financial services — like payments, or securitization — without using a middleman, like a bank.
For use cases that don’t need a high degree of decentralization — but could benefit from better coordination — blockchain’s cousin, “distributed ledger technology (DLT),” could help corporates establish better governance and standards around data sharing and collaboration.
Following are some of the banking services that could be disrupted.
By establishing a decentralized ledger for payments (e.g. Bitcoin), blockchain technology could facilitate faster payments at lower fees than banks.
- Blockchain technology offers a high-security, low-cost way of sending payments that cuts down on the need for verification from third parties and beats processing times for traditional bank transfers
- 90% of members of the European Payments Council believe blockchain technology will fundamentally change the industry by 2025
If you work in San Francisco and want to send part of your paycheck back to your family in London, you might have to pay a $25 flat fee for a wire transfer, and additional fees adding up to 7%. Your bank gets a cut, the receiving bank gets a cut, and you’re charged exchange rate fees. Your family’s bank might not even register the transaction until a week later.
Facilitating payments is highly profitable for banks, providing them with little incentive to lower fees. Cross-border transactions, from payments to letters of credit generated 40% of global payments transactional revenues during 2016.
Cryptocurrencies like Bitcoin and Ethereum are built on public blockchains that anyone can use to send and receive money. In this way, public blockchains cut down on the need for trusted third parties to verify transactions and give people around the world access to fast, cheap, and borderless payments.
Bitcoin transactions can take 30 minutes or up to 16 hours — in extreme cases — to settle. That’s still not perfect, but it represents a leg up from the average 3-day processing time for bank transfers.
More importantly, developers are working on scaling cheaper solutions for cryptocurrencies — like Bitcoin and Ethereum — to process more transactions, faster. Other cryptocurrencies, like Bitcoin Cash and TRON, already have low-priced transactions.
Some examples of payments through blockchain
While cryptocurrencies are a long way from completely replacing fiat (like the US dollar) when it comes to payments, the last couple of years have seen mostly upward growth in transaction volume for cryptocurrencies like Bitcoin and Ethereum.
Some companies are using blockchain technology to improve B2B payments in developing economies. One example of this is BitPesa, a blockchain company focused on facilitating B2B payments in countries like Kenya, Nigeria, and Uganda. The company has processed millions of dollars in transactions, reportedly growing 20% month-over-month.
Another example is BitPay, a Bitcoin payment service provider that helps merchants accept and store Bitcoin payments. The company has over 40 integrations, partnering with e-commerce platforms like Shopify and LemonStand to facilitate Bitcoin payments. Additionally, Ohio has become the first state in the US to accept Bitcoin tax payments, and the transactions are enabled by BitPay’s platform.
2. Clearance and Settlements Systems
Distributed ledgers can reduce operational costs and bring us closer to real-time transactions between financial institutions.
- Distributed ledger technology could allow transactions to be settled directly, and can keep track of transactions better than existing protocols, like SWIFT
- Ripple and R3, among others, are working with traditional banks to bring greater efficiency to the sector
The fact that an average bank transfer — as described above — takes 3 days to settle has a lot to do with the way our financial infrastructure was built.
It’s not just a pain for the consumer. Moving money around the world is a logistical nightmare for the banks themselves. Today, a simple bank transfer — from one account to another — has to bypass a complicated system of intermediaries, from correspondent banks to custodial services, before it ever reaches any kind of destination. The two bank balances have to be reconciled across a global financial system, comprised of a wide network of traders, funds, asset managers and more.
If you want to send money from a UniCredit Banca account in Italy to a Wells Fargo account in the US, the transfer will be executed through the Society for Worldwide Interbank Financial Communication (SWIFT), which send 24 million messages a day for 10,000 financial institutions.
Because UniCredit Banca and Wells Fargo don’t have an established financial relationship, they have to search the SWIFT network for a correspondent bank that has a relationship with both banks and can settle the transaction — for a fee. Each correspondent bank maintains different ledgers, at the originating bank and the receiving bank, which means that these different ledgers have to be reconciled at the end of the day.
The centralized SWIFT protocol doesn’t actually send the funds, it simply sends the payment orders. The actual money is then processed through a system of intermediaries. Each intermediary adds additional cost to the transaction and creates a potential point of failure — 60% of B2B payments require manual intervention, each taking between 15-20 minutes.
Blockchain technology, which serves as a decentralized “ledger” of transactions, could disrupt this state of play. Rather than using SWIFT to reconcile each financial institution’s ledger, an interbank blockchain could keep track of all transactions publicly and transparently. That means that instead of having to rely on a network of custodial services and correspondent banks, transactions could be settled directly on a public blockchain.
Further, blockchain technology allows for “atomic” transactions, or transactions that clear and settle when a payment is made. This stands in contrast to current banking systems, which clear and settle a transaction days after a payment.
That might help alleviate the high costs of maintaining a global network of correspondent banks. Banks have estimated that blockchain innovation could cut at least $20B worth of costs from the financial sector by providing better infrastructure for clearance and settlements.
Examples of transactions using blockchain
Ripple, an enterprise blockchain services provider, is the most prominent player working on clearance and settlement. While the company is best known for its associated cryptocurrency XRP, Ripple — the venture-backed company — is building out blockchain-based solutions for banks to use for clearance and settlement.
SWIFT messages are one-way, much like emails, which mean that transactions can’t be settled until each party has screened the transaction. By integrating directly with a bank’s existing databases and ledgers, Ripple’s xCurrent product provides banks with a faster, two-way communication protocol that permits real-time messaging and settlement. Ripple currently has over 100 customers signed up to experiment with its blockchain network.
R3 is another major player working on distributed ledger technology for banks and wants to be the “new operating system for financial markets.” It raised $107M in May 2017 from a consortium of banks like Bank of America Merrill Lynch and HSBC. It’s also lost some key members, such as Goldman Sachs, which departed because it wanted more operational control over R3.
Projects like Ripple and R3 are working with traditional banks to bring greater efficiency to the sector. They’re looking to decentralize systems on a smaller scale than public blockchains by connecting financial institutions to the same ledger in order to increase efficiency of transactions.
Initial Coin Offerings (ICOs) are experimenting with a new model of financing that unbundles access to capital from traditional capital-raising services and firms.
- In initial coin offerings (ICOs), entrepreneurs raise money by selling tokens or coins, allowing them to fundraise without a traditional investor or VC firm (and the due diligence that accompanies an investment from one)
- Blockchain company EOS raised over $4B in its year-long ICO ending in 2018.
In an ICO, projects sell tokens, or coins, in exchange for funding (often denominated in Bitcoin or ether). The value of the token is — at least in theory — tied to the success of the blockchain company. Investing in tokens is a way for investors to bet directly on usage and value. Through ICOs, blockchain companies can short-circuit the conventional fundraising process by selling tokens directly to the public.
Venture capital firms have taken notice, with Sequoia, Andreessen Horowitz, and Union Square Ventures, among others, all directly investing in ICOs, as well as gaining exposure by investing in cryptocurrency hedge funds.
Venrock partner David Pakman has said, “There’s no question that crypto will disrupt the business of venture capital. And I hope it does. The democratization of everything is what has excited me about technology from the beginning.”
Examples of fundraising through blockchain
While the majority of ICOs thus far have been for pre-revenue blockchain projects, we’re seeing more and more technology companies build around a paradigm of decentralization.
Telegram, the messaging app, for example raised $1.7B via ICO. The idea behind the ICO is to sell tokens to users and bootstrap a payment platform on top of the messaging network. If, as blockchain advocates predict, the next Facebook, Google, and Amazon are built around decentralized protocols and launched via ICO, it will eat directly into investment banking margins.
Several promising blockchain companies have emerged around this space. Companies like CoinList, which began as a collaboration between Protocol Labs and AngelList, are helping bring digital assets to the mainstream by helping blockchain companies structure legal and compliant ICOs. CoinList has facilitated more than $400M in token sales since August 2017.
It has developed a bank-grade compliance process that blockchain companies can access through a streamlined API, helping projects ensure everything from due diligence to investor accreditation. While CoinList’s platform is designed for blockchain projects, its focus on reducing the logistical and regulatory load around fundraising is being mirrored in the public markets. Investment banks today are experimenting with automation to help eliminate the thousands of work hours that go into an IPO.
Of course — given regulatory pronouncements — ICO activity should be taken with a grain of salt, and the rapid rise of ICOs over the past year looks like it was a bubble. And there’s no doubt that many of these projects will fail altogether. What’s interesting is that they’re testing out blockchain technology that could replace functions of traditional banks. This is not just limited to company fundraising, but also to the underlying fabric of securities.
So as you can see there is lots of potential.
This is just part 1 of Blockchain’s Potential to Disrupt Banking Services series, stay tuned for part 2 covering more examples of how blockchain could disrupt securities, loans and credit, and trade finance.
Excerpt originally published by CB Insights, How Blockchain Could Disrupt Banking.
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